Urbanization needs further financial reforms

1. Reasons of financial repression in urbanization

Regulation objectives reduce capital supply for urbanization: the direct or indirect capping of interest rates, higher deposit reserve ratio, and Central Bank’s “window guidance” limits make it hard for banks and other financial institutions to provide sufficient capital for urbanization. Since 2010, most banks have strongly felt their superior’s restrictions, which strictly control the amount of loans allowed and which largely hamper their ability to provide enough funding to finance the urbanization.

Financial products are innovating slower than the urbanization process: on the one hand, safety, liquidity, and profitability are the fundamental principles of commercial banks. On the other hand, urbanization requires long-term and massive supply of social services and construction of infrastructure. These characteristics of urbanization make it hard for commercial banks to possess capital flows and directly gain profits. Furthermore, the unknown risks involved in urbanization will diminish the security of banks and other financial institutions.

Urbanization needs financial support; the overall financial sector benefits from urbanization. But urbanization is developing fast and sometimes is changing unpredictably. However, the financial products provided by traditional institutions are updating slowly, resulting in hysteresis.

Barriers for rural borrowers to obtain loans: the criteria used by commercial banks to screen rural borrowers are basically the same as those for urban borrowers. Such criteria include scales of operation, credit ratings, quality of assets, and liabilities. These criteria can help the lenders to comprehensively assess risks and effectively minimize any possible instability.

However, the screening process does not take into consideration the uniqueness of rural financing. Usually, rural residents and organizations have a relatively small scale of production and cannot meet the prohibitively high standard for credit ratings. Thus, plenty of corporations in rural areas cannot obtain the necessary capital.

Another problem involves collaterals. Individuals and corporations have to provide sufficient collaterals when applying for loans. But the reality is that their scale of operation and assets cannot satisfy the collateral requirement. Meanwhile, many financial institutions are reluctant to engage in any financial activities in rural areas because of the inherent instability of rural economy.

Incomplete structure of financial market: state-owned financial institutions take up too big a portion of the financial industry. Private financial institutions and institutions of small or medium sizes are rare. There is also not a financing pool directly accessible for market participants. Consequently, these factors will limit the further development of China’s financial industry.